Disney May Be A Long-Term Gem At Current Prices

| About: The Walt (DIS)

Summary

Disney stock is currently stuck in a rut, as concerns over the company's media networks division are depressing the share price.

Recent results have been good, though largely dominated by great performance of the studio division.

Disney's alternate distribution efforts could help insulate it if cable distribution really falls away.

I am developing a passive income stream from dividends to generate financial independence. I'm proceeding down the path of steadily accumulating a set of high-quality, dividend-paying stocks. My strategy is quarterly accumulation of 30 stocks through a Motif Investment, with a few thousand dollars invested across all these stocks at a time. Disney (NYSE:DIS) is one of the businesses in my dividend portfolio that I am accumulating.

Operating results overshadowed by longer term concerns.

Disney's stock continues to be stuck in a rut as Disney's media networks division continues to disappoint. This continues an ongoing theme over the past few quarters as questions around the performance of Disney's ESPN segment and concerns about reduced revenues from cable networks dominate Disney's stock price performance .

Disney performed well in Q1 '16. The company reported that revenue increased 14% year on year, with operating income up 20% year on yet. In spite of this, market reaction was negative. Disney's media networks segment again had a 6% decline in operating income as the increased cost of rights took a toll on income. That overshadowed solid performance from the company's studio entertainment segment, which had a 46% year on year revenue increase and an 86% improvement in segment income.

Investor concern about the media networks segment is understandable given that close to 45% of Disney's revenues come from this division. This business is substantially dependent on fees paid by cable companies to Disney based on the number of subscribers viewing Disney content.

Is dependence on the cable model a problem?

Broader trends in the cable ecosystem suggest that the cable business model is still holding up fairly well. Comcast's (NASDAQ:CMCSA) recent results seem to indicate that the spate of cord cutting and the bleeding that has been taking place in cable video has abated. For how long this is the case is uncertain, but Comcast recently reported 4Q 2015 results that saw a net addition of 85,000 cable video subscribers, the best quarterly result in almost 8 years. This follows years of customer decline in the cable video service.

However one of the underlying trends in the cable industry is the introduction of "skinny bundles". Broadcasters such as Verizon (NYSE:VZ) are introducing skinny bundles into the market which often don't feature Disney content. The thinking is that these lower cost, reduced content cable bundles will appeal to a subset of subscribers for whom a more full featured cable service is of limited utility. If these lower cost, "skinny bundles" become more popular, they may jeopardize Disney's long-term affiliate revenues from cable.

Disney's unique content is tough to replicate

Disney has pioneered numerous successful character franchises that get run through a virtuous cycle of consumer products, games and figurines, inclusion in theme parks and then their own debut on the big screen via studio entertainment. Mickey Mouse, Winnie the Pooh, Star Wars, Monsters, Spider-Man, Cars, Disney Jr. and the Princesses account for more than $1B each in sales volume. Provided Disney doesn't lose its knack for either organically developing new franchises, or being able to identify and acquire them at reasonable cost, it will continue to have long-term success.

Investments in alternative distribution are occurring

Disney seems to be aware that it may need to diversify its distribution strategy beyond just cable distribution.

The company acquired Maker studios, which gives it access to an online property with a heavy millennial base that are difficult to reach through traditional cable.

The company is also investing in platforms like Jaunt, which is involved in Virtual Reality. Ostensibly, this may provide Disney with a new platform to bring its content stable to a new audience in a different way.

While these platforms will help get Disney content in front of new audiences, new monetization models will need to be pioneered to extract a suitable return on investment. What is clear is that these alternative platforms do not offer the attractive economics of cable distribution, with a fixed payment per subscriber.

Dividend & Valuation

Disney seems to have been harshly marked down, in spite of solid results. At $96 a share, Disney currently trades at a P/E ratio of 18 and a forward P/E ratio of just over 15. Disney is trading below average multiples over the last 5 years including price to earnings and price to cash flow. Morningstar rates Disney stock at 4 stars at present.

Disney's 1.5% dividend yield is higher than it has been for the last few years. With a very modest payout out of only 37%, Disney will be able to comfortably maintain and aggressively grow the dividend even with the current questions around the long-term fate of cable distribution.

With the cable model showing no signs of disappearing any time soon, Disney shares may be a good buy for the patient, long-term investor.

Disclosure: I am/we are long DIS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.